Gassing Up (or Down)"

How long can gas prices stay so low?

Gas prices have fallen dramatically. And they feel really, really low because they seem to have fallen without a major catalyst. We’re so used to feeling helpless in the face of higher prices that we don’t know what to do with the good news. And so we speculate that the lower prices will just be temporary, as they were in 2009, or that weather, war, or some other disaster will push them back up.

In fact, apart from the 2009 financial crisis, we’ve only seen this kind of fall in gas prices once in the past 40 years, and that time it wasn’t so sudden. From 1982 to 1986 real gas prices slid by over 50%, collapsing in 1986. They stayed between $1.50 and $2.00 per gallon, in real terms, for the next 17 years, until 2003. This mirrored the period of high prices the economy experienced from approximately 1970 to 1981.

Source: Energy Information Administration

Back in 2005 many estimated that the marginal price of crude oil production was about $75 / barrel, implying $2.00 gas (at that time). But prices overshot that target—due to war and weather—and we saw crude above $150 and gas above $4.00. That period of overpricing led to overinvestment and excess capacity. It was said that the surest path to a six-figure income was an undergraduate degree in petroleum engineering from the South Dakota School of Mines.

As in the 1980s, the chickens of overinvestment are coming home to roost. Lower prices in the presence of a stronger economy mean capacity needs to be worked off. We had above-equilibrium prices for about 8 years. It would be no surprise to see below-equilibrium prices for about the same period.